Risk/Reward ratio
Nominex
There is always a certain risk in any investment, otherwise, it would be difficult to get a good reward.
Risk is the volatility of return versus its expected value.
Profitability is the sum of income received from investments in an asset and changes in its market price, which is expressed as a percentage of the initial market price of the investee.
The return is directly proportional to the risk, i.e. the greater the risk, the greater the profit.
Types of risks
The relationship between risk and reward indicates whether riskier investments provide higher returns and vice versa. The essence of the problem is to determine the most appropriate option for oneself in the Risk/Reward ratio.
There are several types of risk that a crypto investor faces in their activities:
• Systematic risk — its nature in external factors influencing the economy and the market.
• Unsystematic risk is inherent in an individual-specific financial asset and is associated with its specifics.
• Speculative risk — an unexpected change in the value of an asset caused by the actions of the trading participants themselves.
• The human factor (personal risk) is errors associated with the qualifications of the investor.
Diversification is the key to reducing risk. Without the right diversification strategy and an understanding of the types of risks associated with each type of investment, your investment may not be profitable.
When you decide to invest in altcoins that are riskier than Bitcoin or Ethereum, to some extent you risk facing the following circumstances:
• Loss of principal
Any cryptocurrency can simply depreciate.
• Lagging behind inflation
This happens if your investment is growing in price more slowly than the actual prices in the market. In other words, you can lose against the US dollar or Bitcoin.
• Paying high commissions or other costs
Expensive trading fees and bids or hidden costs can seriously hinder your ROI.
Risk/Reward ratio
Many investors use risk-reward ratios to compare the expected return on investment with the measure of risk they must take in order to earn.
Consider an example: an investment with a risk/reward ratio of 1:5 assumes that the investor is willing to risk $1 in the hope of earning $5.
Traders often use this approach to plan their trades, and the odds are calculated by dividing the amount a trader can lose if the price of an asset moves in an unexpected direction (risk) by the amount of profit the trader expects to lock in when the position is closed (reward).
Hence, the risk/reward ratio is a key indicator of how well you have allocated your funds.
In general, the risk is calculated as follows:
where rn is the profitability for the n-th period, usually annual,
r̄ is the arithmetic average of the asset's return over the entire holding period,
n - the number of periods: if we count by the annual rate of return, then the number of years.
The yield is calculated as follows:
where Pt + 1 is the price of the asset now or at the time of sale,
Pt - the price of the asset at the time of purchase,
CF is the interim cash flow that the asset brought during the time it was owned - for example, dividends paid.
Pros of investing in risks:
• Reward for additional risk;
• Possibility of calculation, allowing to minimize the negative consequences of the risk;
• The theory is convenient and easy to apply in practice.
Minuses:
• Tough competition;
• Threat of currency depreciation;
• Ratios are based on the past history of the asset's movement, which does not guarantee future success.